Buckle Up – It’s Going To Be A Bumpy Ride

Despite a positive start to the year for equities, asset managers are showing a distinctly negative view.

2019 has been a good year for investors so far. The S&P index of 500 US stocks is up 12% since 01 January; the FTSE 100 by 7.2%. Here in the Gulf, the Tadawul has rewarded investors with a 9.6% rise year to date. 

And yet new research shows that institutional investors are at their most bearish for some years, rotating into cash and other defensive assets as they adjust their allocation in preparation for uncertain times ahead. 

Each month, US investment bank Bank of America Merrill Lynch (BAML) surveys institutional investors responsible for $625 billion of assets. It asks the same questions each month that it has done for many years, giving some fascinating trend data and insight into the mindsets of the world’s leading asset managers. And the February 2019 results seem to indicate a mood of pessimism in the investment community. 

Some key data points:

• Allocation into equities is at its lowest since 2016
• The number of managers “overweight cash” is at its highest since 2009
• 34% believe the S&P has peaked at 2931 (it stood at 2808 on March 15^th)
• 55% believe growth will be below trend for the next 12 months 

This downbeat mood should not be a surprise: Investors endured a bruising end to 2018. After nine months of serenely rising global indices, the fourth quarter saw a spike in volatility and a correction in asset prices. Indeed, so extreme was the market volatility in December, that several large global banks saw their annual profits wiped out in a few weeks. So it is hardly surprising that asset managers entered the new year in a cautious mood. 

Investment managers take a prudent view of risk, and seek to manage and mitigate it through sophisticated strategies. They are paid to manage risk on behalf of their end-investor clients, so their bearish outlook on the back of a volatile and damaging December is understandable. 

All risk can be divided into one of two types: those that can be influenced or controlled, and those that cannot. 

And the biggest risk cited in the BAML survey is one that is beyond the control of the asset management industry: the threat of global trade wars. Investors are taking the current political rhetoric seriously, and are taking defensive positions in the expectation of damaging geopolitical economic quarrels becoming reality. 

But while trade wars may be beyond the control of investors, they are also keeping a keen eye on risks that they can actively mitigate, and topmost among these is the balance sheets of their invested companies: Survey participants were asked how they would like to see companies use their cashflow. The number one response was to improve balance sheets (51%, the highest since July 2009). 

Investor concerns about debt are on the rise, and are matched by concerns among regulators. The Financial Stability Board, the global financial regulator, recently announced that it is to launch an enquiry into the $1.4 trillion leveraged loan market. When regulators and investors agree on the severity of the risk, and are acting to mitigate it, we can take that as a sign that there is a potential problem lurking here. 

Listed companies which have taken advantage of abundant and cheap debt since the financial crisis may now find themselves under pressure from both regulators and shareholders to cease drinking from the credit fountain.   

In a sign of how seriously investors are taking the issue, returning cash to shareholders as a preferred use of cashflow was only cited by 10% of respondents as being desirable, a record low. As recently as 2013, some 40% of institutional shareholders were asking for cash to be returned to them. 

The BAML survey is only one piece of evidence in a complex capital market infrastructure. Yet it carries important messages for listed firms and their IR teams, and they need to understand these concerns and drivers when they engage with their shareholders. 

Prudent risk management is what asset managers are paid to do. But when they demand that firms stop returning cash to them and start strengthening their balance sheets, it is time for companies to stop, listen, and engage in a strategic dialogue.